There's Reason For Concern Over Shang Gong Group Co., Ltd.'s (SHSE:600843) Massive 36% Price Jump

Despite an already strong run, Shang Gong Group Co., Ltd. (SHSE:600843) shares have been powering on, with a gain of 36% in the last thirty days. Looking back a bit further, it's encouraging to see the stock is up 47% in the last year.

Following the firm bounce in price, Shang Gong Group's price-to-earnings (or "P/E") ratio of 78.2x might make it look like a strong sell right now compared to the market in China, where around half of the companies have P/E ratios below 32x and even P/E's below 20x are quite common. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's so lofty.

The earnings growth achieved at Shang Gong Group over the last year would be more than acceptable for most companies. It might be that many expect the respectable earnings performance to beat most other companies over the coming period, which has increased investors’ willingness to pay up for the stock. If not, then existing shareholders may be a little nervous about the viability of the share price.

See our latest analysis for Shang Gong Group

Although there are no analyst estimates available for Shang Gong Group, take a look at this free data-rich visualisation to see how the company stacks up on earnings, revenue and cash flow.

What Are Growth Metrics Telling Us About The High P/E?

In order to justify its P/E ratio, Shang Gong Group would need to produce outstanding growth well in excess of the market.

Taking a look back first, we see that the company managed to grow earnings per share by a handy 7.6% last year. Ultimately though, it couldn't turn around the poor performance of the prior period, with EPS shrinking 58% in total over the last three years. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.

Comparing that to the market, which is predicted to deliver 38% growth in the next 12 months, the company's downward momentum based on recent medium-term earnings results is a sobering picture.

With this information, we find it concerning that Shang Gong Group is trading at a P/E higher than the market. Apparently many investors in the company are way more bullish than recent times would indicate and aren't willing to let go of their stock at any price. There's a very good chance existing shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with the recent negative growth rates.

The Key Takeaway

The strong share price surge has got Shang Gong Group's P/E rushing to great heights as well. It's argued the price-to-earnings ratio is an inferior measure of value within certain industries, but it can be a powerful business sentiment indicator.

We've established that Shang Gong Group currently trades on a much higher than expected P/E since its recent earnings have been in decline over the medium-term. When we see earnings heading backwards and underperforming the market forecasts, we suspect the share price is at risk of declining, sending the high P/E lower. If recent medium-term earnings trends continue, it will place shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

You need to take note of risks, for example - Shang Gong Group has 3 warning signs (and 2 which make us uncomfortable) we think you should know about.

If P/E ratios interest you, you may wish to see this free collection of other companies with strong earnings growth and low P/E ratios.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.